Portugal bailout talk hits stocks, euro

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Europe's debt crisis returned to the fore of investor concerns on Monday amid reports Portugal is facing mounting pressure to accept an aid package to prevent contagion to other countries.

Stocks in Europe have fallen sharply as Portugal's market borrowing rates have jumped higher in the wake of the renewed bailout talk.

In Europe, the FTSE 100 index of leading British shares was down 20.60 points, or 0.3 percent, at 5,963.73 while Germany's DAX fell 41.47 points, or 0.6 percent, at 6,906.37. The CAC-40 in France was 47.02 points, or 1.2 percent, lower at 3,818.56.

As stocks dropped, the yield on Portugal's ten-year bonds rose nearly half a percentage point to 7.14 percent. That's unsustainable in the medium-term and comes ahead of an auction of euro1.25 billion in three year and nine year bonds on Wednesday.

The yields' spike higher follows a report in German newspaper Der Spiegel that France and Germany are pressing Portugal to tap a European rescue fund to keep the crisis from spreading to much-bigger Spain. Portugal denies it needs to do so but that doesn't mean it won't, if recent experience is anything to go by.

Analysts said there are distinct echoes of what went on with Ireland just a couple of months ago. Before Ireland was forced to accept a rescue from its partners in the European Union and the International Monetary Fund, there were numerous reports suggesting that Germany, in particular, was pressuring Dublin to take the funds to stop the crisis spreading. The Irish government also insisted it didn't need any help before eventually accepting a euro67.5 billion bailout.

"It therefore seems reasonable to suppose that events will move rapidly this week as the authorities work to put together a credible support mechanism," said Simon Derrick, a senior analyst at Bank of New York Mellon. "A failure to do so would, of course, send an extremely negative message to the markets."

Finance ministers of the 17 countries that use the euro are set to meet next Monday in Brussels. Before then, however, is Wednesday's Portuguese bond auction, which will be a key test of investor sentiment.

On Thursday, Spain and Italy are also scheduled to sell bonds and the big worry in Europe's capitals is that Spain, in particular, will be dragged into the mire.

The prevailing view in the markets is that Europe will be able to rescue Portugal but that emergency support for Spain would test the limits of the existing bailout fund, potentially putting the euro project in jeopardy if governments don't put up more cash. Spain makes up around 10 percent of the eurozone economy, whereas Greece, Ireland and Portugal only account for around 2 percent each.

Against this backdrop, the euro is foundering - by late morning London time, it was down modestly on the day at $1.29, meaning it has fallen around 5 cents so far this year.

U.S. stocks were also poised to open lower after ending last week on the backfoot following a fairly disappointing U.S. jobs report for December - Dow futures were down 27 points at 11,619 while the broader Standard & Poor's 500 futures fell 2.7 points to 1,267.50.

The pace of the U.S. economic recovery has been the main focus of attention so far this year and will continue to affect investor sentiment this week alongside developments in Europe's debt crisis.

"In the U.S., plenty of key data at the end of the week (industrial production, retail sales) should support the notion of a 'stronger' recovery despite a tepid jobs report last Friday," said Neil MacKinnon, global macro strategist at VTB Capital.